Executive Summary

Commission allocation begins with the broker vote. In order to calculate their commission budgets, buy-side firms typically conduct an internal process in which all of a firms portfolio managers, analysts and sometimes traders qualitatively assess the value of the various services provided by different brokers and decide which firms services they want to buy.

The management of that broker vote can be a relatively straightforward process. However, depending on the structure of an organization, this practice can become quite complex. Unfortunately, evaluating and appraising research and other broker provided services is a necessary evil. The buy side must confirm it is receiving the appropriate quality and quantity of services for their commission dollars. The good news is that advancements in technology have made it easier for both the buy side and sell side to put in place a formal process that can track all brokerage resources consumed as well as place a value on those products and services.

Many factors influence how firms conduct a vote including the size of the firm, the number of regions an organization operates in, the number of sectors they cover, and how many brokers they have. Depending on the policy and strategy of a buy side firm, only certain members of the firm will participate in the broker vote. For those who are allowed to participate,not many firms structure the vote, so that the weighting is based on function, seniority or other characteristics. A major difference in policyfrom firm to firm is whether or not a trader should participate in the broker vote. Some say the trader should focus on best execution, and thus is not allowed to vote, while others operate under the notion that a trader can shed light on how well brokers are servicing the firm.

While some firms are implementing commission management and broker voting software, others have stuck with the tried and true Excel spreadsheet. The firms implementing solutions are often ones that have come torealize thatit has become arduous todisseminate spreadsheets to all the groups within the firmwho interact with a broker on a daily basis. Aggregating and analyzing the results from a multitude of groups can also be time consuming. In addition, capturing each interaction by simply sharing or attempting to consolidate spreadsheets can lead to a loss of integrity as it is passed back and forth between users. Moreover, this process leaves data more vulnerable to fraud due to the lack of controls characteristic of most Excel sheets passed back and forth since most sheets are unlikely to be password protected or encrypted in any way. Moving the broker vote to an electronic platform helps ensure that every point of contact is submitted and stored in a central location and helps alleviate a very labor intensive and tedious process.

There are several vendors that offer services around broker voting to help automate the process. These providers give the buy side a mechanism toconsolidate andkeep track of all the services consumed or not consumed across the firm and formulate budgets for each quarter. These systems also include a full list of service providers, including brokers, market data vendors, and independent researchoutfits.Tracking commissions paid out between votesto ensure payouts are in line with projected targets is another useful function.

Buy side firms also vary in how much detail they reveal to their brokers about the results of the vote. At one extreme, firms can be very transparent sending out report cards with rankings and comments from voters. At the other, a buy side firm may choose to give no feedback at all unless a broker makes a specific inquiry. There are others who fall in the middle only revealing information on a brokers tier relative to their peers.

From small hedge funds to large asset managers, whether formal or informal, the broker vote is an integral part of commission management. With the regulatory environment moving toward an increased unbundled structure and an increase in compliance requirements for transparency around research, firms need to implement a process that tracks the rationale behind paying out commissions to brokers. Money managers are also faced with answering questions from their own fund clients about why they are paying commissions to various brokers. The broker vote is the beginning of a very important process in which money managers can assess the valueof research services from brokers in order to determine how eligible research commissions will be allocated.

The Broker Vote: Complexities of the Buy Side Ballot

In this Vision note, TABB Group examines how the buy side conducts an internal vote on services of their brokers. The report covers thetrends in buy-side voting practices, broker voting software,and theimpact of the broker vote on the entire commission management process. For this study TABB spoke to over 20 buy side firms in the US and Europe along with global brokers and vendors who provide broker voting tools.